Friday, 24 April 2015

The world economy is not strong and the President of the United States is
sufficiently concerned about new shocks to it that
he recently met the Greek Finance Minister to urge ‘flexibility on all
sides’ in the negotiations between the Syriza-led government and its creditors.
US concern is fully justified.

In any attempt to reach agreement it is important both to have an objective
assessment of the situation and to understand the perspective of those on the
opposite side of the table. In Mythology that blocks progress in Greece
Martin Wolf, the chief economics commentator for the Financial Timesargues
that negotiations to date are dominated by myths. He demolishes some of
these key myths in turn: that a Greek exit would make the Eurozone stronger,
that it would make Greece stronger, that Greece caused the crisis driven by
private sector lending, that there has been no effort by Greeks to repay these
debts, that Greece has the capacity to repay them, and that defaulting on the
debts necessarily entails leaving the Eurozone.

Together, these provide a useful corrective to the propaganda emanating from
the Eurogroup of Finance Ministers and ECB Board members. Some if this is
slanderous, in repeating myths about ‘lazy Greeks’ (who have among the longest
working hours in Europe). Much of it is delusional, based
on the notion that Greece can be forced to pay up, or forced out of the Euro
without any negative consequences for the meandering European or the world
economy.
Austerity ideology

The genuine belief in a false idea, or a demonstrably false system of ideas
constitutes an ideology
in the strict meaning of that word. Inconvenient facts are relegated in
importance or distorted, and secondary or inconsequential matters are magnified.
Logical contortions become the norm.

All these are prevalent in the dominant ideology in economics, which is
supplemented by another key weapon, the helpful forecast. In Britain for
example, supporters of austerity argued it would not hurt growth and the deficit
would fall. Now there is finally a recovery of sorts, they argue austerity
worked, ignoring all the preceding five years and the unsustainable nature of
the current recovery (and the limited
progress in reducing the deficit).

For Greece the much more severe austerity and its consequences means that
supporters are still obliged to rely on the helpful forecast to support their
case. The Martin Wolf piece includes a chart of IMF data on Greek government
debt as a percentage of GDP, which is reproduced in Fig.1 below.
The IMF includes not only data recorded in previous years but its own
projections for future years. From a government debt level of 176% of GDP in
2014, the IMF forecasts a fall to 174% this year and 171% in 2016 and much
sharper declines in future years. The IMF has also forecast an imminent decline
in Greek government debt ever since austerity was first imposed in 2010, which
has not materialised.

Fig. 1 Greek Government Debt, % GDP & IMF Projections

However, the most recent data released by the Greek statistical service
Elstat shows
that Greek government debt rose once more (pdf) at the end of 2014 to stand
at €317bn. The total debt was €9bn higher in 2014 than 2013, whereas the IMF
forecast is effectively flat. Worse, as the Greek economy is still contracting
the debt as a proportion of GDP will be rising sharply, not falling as
officially projected.

In the course of 10 years the Greek government debt level has effectively
doubled as a proportion of GDP close to 180%. Most of this took place while
austerity was being implemented. The unavoidable verdict is that the debt burden
is unstainable and that austerity will only increase it.

To date the Syriza-led government has met all its obligations to creditors
but this clearly cannot go on for very long. It is possible that it may prefer
to default on the ECB, which can in the end simply print the money (as with its
Quantiative Easing programme, but from which it currently excludes Greece).

Defaulting on the IMF is perhaps more politically difficult, as its Board would
have to convene a meeting of all shareholders. €3.46bn is due to the ECB on July
20.

But a default is necessary and inevitable. The authors of the Maastricht
Treaty thought that anything more than debt level equal to 60% of GDP was
dangerous. Then this would provide an appropriate target for Greek debt
reduction.
Investment flows

In the Martin Wolf piece he also suggests that debt reduction should occur
“after the completion of reforms”. This is mistaken. ‘Reform’ in the context of
the negotiations is a synonym for deregulation, privatisation, attacks on
workers’ rights and living standards. This has already been tried and failed. It
is a myth that too many Greek regulations, or too much state ownership, or
workers fighting for better pay and pensions is the cause of the crisis. All
those were in place in 2003 and 2004 when real GDP in Greece grew by 6.6% and 5%
respectively.

One myth that hardly needs to be dealt with any longer is that the crisis was
caused by imbalances within the Eurozone current accounts (the balance of trade
plus overseas interest payments). For a period this became a key explanation
of the crisis (pdf) in the official ideology. It has been largely abandoned
as all the crisis countries have swung into surpluses. Greece now has a current
account surplus because imports have slumped and so remains in crisis.

A common feature of the crisis countries is that they were beset by huge
inflows of private sector capital seeking returns, primarily through speculation
in property and housing. It was when these private sector inflows dried up and
reversed that the crisis became apparent. Until austerity was imposed in 2010
the fall in Greek GDP due the recession was almost exactly the same as in
Germany or in Britain, a fall of approximately 4.75% in all cases.

The austerity policy and the ratings’ agencies induced panic had the effect
of driving capital flows back from the ‘periphery’ to the ‘core’ countries.
Ferocious austerity in Greece and the other crisis countries meant that private
sector banks withdrew capital and repatriated it to the key banking centres of
Europe: Britain, German, the Netherlands and France.

These private sector speculative flows were destabilising in both directions.
They caused both the boom and the bust in Greece and elsewhere. A solution based
on reviving these flows, with the inducement of ‘reform’ can only end in renewed
destabilisation and crisis. The desperation of these private sector investors is
demonstrated by the fact that, for most industrialised countries currently
(excepting Greece) borrowing rates are close to zero as unutilised capital seeks
a return.
Structural adjustment

The Greek economy needs structural adjustment. For the ideologues of
austerity this is a synonym for wage cuts. But Greek finance minister Yannis
Varoufakis is right, cutting wages even further will have no effect on
improving Greek competitiveness in key industries, “we are not going to be
competitive with Mercedes-Benz and Toyota, simply because we don’t make cars.”

The structural adjustment needed is to increase the productive capacity of
the Greek economy. This requires productive investment on a large scale. Prior
to the crisis the EU did provide some transfers of funds for investment, as well
as current transfers in the form of the Common Agriculture Policy and other
funds (which is why the anti-austerity parties and most voters in the crisis
countries are not anti-EU). However, these were on an insufficiently large scale
and were in any event overwhelmed by the private sector inflows which were
primarily directed towards construction and housing.

Worse, the EU has cut its funding for investment as the crisis has deepened.
This has exacerbated the private sector withdrawal of capital and is an
important factor in prolonging the crisis. Fig.2 below shows the levels of
investment from the EU and the different forms of investment from the private
sector, both total investment (Gross Fixed Capital Formation) and productive
investment, which excludes housing.

Fig.2 Investment in Greece & Selected Components, % GDP

All types of investment have fallen as a proportion of GDP during the crisis.
But it was the EU’s declining contribution which led the way. In addition, the
real cuts in investment are flattered in this comparison as GDP itself was
falling. In 2006 productive investment from the EU to Greece amounted to €4.7bn.
In the depth of the crisis in 2012 it had been cut to €1.6bn.

This is a punitive measure and is entirely contradictory to the objective
needs of the Greek economy. All properly functioning single currency areas
require significant fiscal transfers in order to be sustainable. This follows
from the fact that all regions or countries in a monetary union are subject to
very similar monetary conditions (official interest rates, exchange rates, and
so on) yet have very different levels of productivity. Those levels of
productivity will diverge to a crisis point unless there are sufficient fiscal
transfers to compensate. If the fiscal transfers are sufficiently large and
well-directed, they can even compress or reverse the divergence in productivity.
Currently, the policy of the Troika is to lay siege to the government in Athens
in an attempt to starve it into submission.

As a result, the Greek economy is at that crisis point. It requires very
large fiscal transfers otherwise it will diverge out of the Eurozone. This is in
addition to the requirement for a very substantial debt write-off already noted.
Even then, very strong government and supranational measures would be required
to direct the inevitable revival of private sector investment that would
inevitably follow a large increase in (supranational) public sector investment.
The public sector must begin to direct large-scale investment.

Martin Wolf is quite right to attempt to disabuse the ideologues of austerity
of their Greek myths. There is no prospect of an end to the crisis without very
substantial debt reduction. It is also reckless bravado to claim that only
Greece would be hit by a forced exit from the Euro. But even debt reduction is
insufficient to end the crisis, and further ‘reforms’ would only deepen it. Very
large fiscal transfers to pay for a structural upgrade of the Greek economy are
necessary.

The biggest beneficiaries of the EU are the big firms and banks in the
leading EU economies. They need to start paying for this benefit or they will
lose it.

Tuesday, 14 April 2015

The Tory manifesto election pledge to make housing associations sell their homes at a discount and force local authorities to sell off some of their best stock has been widely condemned by the associations themselves and by housing experts. The government has set aside £1 billion to fund the discount available to the new ‘right-to-buy’ owners and will demand that the housing associations build replacement homes, which do not have to meet affordability criteria. The net new money available for homebuilding is therefore just £1 billion.

Using average construction cost estimates from the
National Association of Home Builders of £150,000 per home, this equates to just
6,600 homes. Very few or none may be affordable.

The idea of bribing a tiny number of housing association tenants (and some of
the few remaining local authority ones) with public money to become
owner-occupiers is part of the policy of privilege to bolster the Tory election
campaign. But since the majority of these homes tend rapidly to become part of
the private rented sector it will also exacerbate the growing inequality and
unaffordability of housing.

It does nothing to address the housing shortage in Britain, which is both
chronic and in many parts of the country acute. Fig.1 below shows the level of
both new ‘social rent’ housing and total affordable homes from 1991 to 2014. It
is necessary to include at least these two categories in order to indicate some
general trends as the government has changed the definitions of many categories
of housing with the effect of obscuring to wider picture.

Fig.1 Social Rent and Total Affordable new homes

To give an indication of how grossly inadequate this is, the number of
(loosely-defined) new affordable homes of all types was just under 43,000 last
year and compares to 1.368 million households on local authority housing waiting
lists in England alone.

The recent peak level for annual new affordable homes was just over 60,000
and was inherited by this government from the previous Labour government. The
official projection of new household formation over the next 25 years is an
average 210,000
per year (pdf). While not all of these households will want or need social
or affordable housing, the majority will. Therefore the current pace of home
building is completely inadequate to meet the additional projected demand. It
will do nothing to address the backlog on waiting lists and the housing crisis
will deepen.

There are many addition costs to the housing crisis simply beyond the
extremes of unaffordability. These include the miseries of overcrowded and
substandard housing, the increasing transfers of household incomes to landlords
and the distortions to wider society, including the workforce. The
much-discussed ‘productivity
puzzle’ (pdf) is much less baffling when it is noted that under this
government the rise in real estate jobs has far outstripped the rise in
construction jobs, as shown in Fig. 2 below.

Fig. 2 Change construction and real estate jobs under the current
government

Solutions to the housing crisis
Labour has adopted a policy of aiming for 200,000 new homes per year by the
end of the next parliament. This would come close to meeting the projected rate
of new household formation. This would also have the effect of moderating the
rise in house prices. But it would be unlikely to reverse it, especially as the
housing shortfall as indicated by local authority waiting lists would have
increase to beyond 1.75 million for Britain as a whole in the meantime.

One of the many myths surrounding government policy is that the state is not
intervening in the economy. The reality is the opposite. There are innumerable
ways in which this government and its predecessors intervene in ‘the markets’,
with costs running into the hundreds of billions of pounds. The bank bailout was
only the most spectacular example.

In the housing sector this government has intervened repeatedly in order to
boost prices without ever boosting the construction of new affordable homes,
which has decreased. Perhaps the most notorious of these schemes is the £40
billion ‘Help to Buy’ policy which uses public funds to boost private property
prices which were already excessive.

A radical step that the next Labour government could take is to use this same
£40 billion guarantee and offer it to local authorities to build new homes. The
first 20% of (unlikely) local authorities’ losses on construction of affordable
homes could be guaranteed using these funds. At the same time, government could
borrow to increase the funds available for construction.

The arithmetic of borrowing to invest in new public affordable housing is
simple and compelling. A 5% rental income on a £150,000 home amounts to £625 per
month. A 3% yield requires just £375 per month. Yet the government can now
borrow at well below even 3%. It would make money on its housing investment,
which could be used for investment in other areas, all of which would see the
deficit fall as a consequence. Housing affordability (and quality) would improve
and job-creation switch from estate agency towards building.

The big losers from a radical policy would be private landlords who no longer
benefit from the upward spiral of house prices and the large ‘house builders’,
the companies who do not build homes but sit on undeveloped land banks and count
the paper profits of the increasing land and home values.

Thursday, 2 April 2015

There is an old joke, not a very good one, that the definition of a
consultant is someone who you pay to tell the time who then asks to borrow your
watch. Osbornomics, the specific variant of austerity economics that operates in
Britain is similar.

The British economic ‘recovery’ is the centrepiece of the Tory election
campaign and has been blessed by the IMF as a model. But the recovery is
entirely fake. On some of the most important measures of average living
standards the economy has at best stagnated over 5 years,
on others they have fallen. The majority of the population has seen their
real living standards decrease. The Tory election slogan should be, “You’ll
never have it so good again”.

The essential con-trick of Osbornomics can be illustrated in one chart, Fig.
1 below. This shows the household savings ratio, the proportion of savings
relative to household incomes.

Fig.1 Household savings ratio

The Tory-led government came to office when the household savings ratio was
10.9%. In the final quarter of 2014 it had fallen to 5.9%. The ‘recovery’ is
essentially driven by this fall in household savings, which is equivalent to
approximately 3.75% of GDP. But, as already noted real living standards have not
been rising. The household sector has been running down savings in order to
finance consumption. This is the epitome of British boom-bust cycles since the
Second World War, although formerly there was at least some increase in living
standards for a period. This promises to be a boom-bust cycle without the
preceding boom.

Debt and deficit obsession

The run-down in household savings highlights a key fallacy of government
policy, which it claims is focused on reducing government deficits and debt. In
Western Europe the entire economic debate is dominated by the distraction of
government finances. In most of the rest of the world, and this means
overwhelmingly in countries that are growing more strongly than Western Europe
or Britain economic policy debate centres on the issues of growth. This is not
only true in fast-growing Asia and Africa, but also in the more sluggish
Americas, including in the US where growth rates have been stronger than Western
Europe since the recession began, and yet remain feeble by historical
comparison.

In Britain, to the limited extent that government deficits have been reduced,
as the economy has been stagnant government deficit-reduction has relied on
increasing borrowing elsewhere, among households. This illustrates a general
truth. Savings and lending must equal each other (aside from money stuffed under
the mattress or similar hoarding). All borrowing/lending is a transaction which
creates both an asset and a liability; a lender and a borrower.

In common with other Western European countries, Britain’s programme to
reduce its government deficit has relied on reducing the savings/increasing the
borrowing of the household sector. But in the mainstream economics textbooks a
normally functioning industrialised economy is supposed to include a household
sector that is acting as a net saver (for big purchases, for retirement and so
on). It is the business sector which is supposed to borrow to supplement its own
profits in order to invest. In fact, it is this process which is mediated
through the banks and which its supporters claim is the uniquely positive
attribute of capitalism. Relying on falling household savings to finance
consumption cannot lead to increased productivity and is inherently
unsustainable.

Over a prolonged period and well before the 2008 to 2009 recession businesses
(PNFCs) have not been performing their allotted role. Businesses have been
savers. The pre-recession boom was financed by a run-down in household savings.
As PNFCs started to increase their savings once more at the end of 2006 the
government began to borrow. It was only after this period, in late 2008 when the
recession had already begun that households sharply reverted to their allotted
role and increased their savings once more. Because both the business and the
household sector were now significant savers, the government was obliged to
increase its borrowing.

The austerity policy attempts to address this imbalance by decreasing the
government’s borrowing by cutting its spending and increasing its income. It
does this by forcing a reduced saving of households, through raising VAT,
cutting social security benefit, cutting disability benefits, public sector pay
and pensions and so on. At the same time it has lavished funds on the private
sector businesses (cutting corporate taxes, privatisations, and so on) in order
to increase their incomes (profits) and eventually to increase their spending
and borrowing.

Economically this policy has failed. The government deficit remains
stubbornly high and both living standards and GDP are stagnant. Most importantly
the austerity to date has failed in its central purpose which is to revive the
profitability of British companies, which is the only conceivable basis on which
they could be willing to increase investment. Fig.3 below shows the trend in the
profit share of UK companies since 1995. At most the policy of austerity has
stabilised the decline in profitability and prevented a further fall. But this
is very far from a recovery in profits (and even further from a recovery in the
profit rate) which would lead to an autonomous rise in private sector
investment.

Fig.3 UK Profit share

Austerity back on the agenda
For a combination of economic and political reasons the Coalition government
stopped implementing new austerity measures midway through the current
Parliament. SEBidentified
this at the time, and now it has become a rather more commonplace analysis.
It was this halt to new austerity measures combined with the effects of
Quantitative Easing and other government measures to boost consumption which
have led to the unsustainable upturn in economic activity.

But a faltering economy and plunging Tory opinion poll ratings meant that the
drive to push down the savings rate of households also had to be suspended. With
the government attempting to lower its own borrowing and businesses showing
little sign of investing rather than saving profits, the necessary savings had
to come from another source. This was the ‘Rest of the World’ (RoW) sector in
the national accounts, which is overseas investors.

For ease of presentation borrowing from the RoW was not shown in Fig. 2
above. But given that the savings of both the household and PNFCs sectors have
been static in the recent period, it is worth illustrating just the growing
dependence on borrowing from overseas and the government deficit in Fig. 4
below.

Fig. 4 Sectoral Accounts; Government borrowing and Rest of World
saving

The business expansion before the recession was in part financed by increased
overseas borrowing (red line). At the end of 2007 the level of government
borrowing in the final quarter was almost exactly equal to the level of savings
by the Rest of the World. But the effect of the recession was to decrease
consumption financed by borrowing from overseas. In the 2nd quarter
of 2011 the level of borrowing from overseas was less than £1bn even though
government borrowing in the same quarter was almost £32bn. The savings then were
supplied by both the households and PNFCs (as shown in Fig.2).

Since that time the quarterly level of government borrowing has fallen by
£13.5bn and the level of borrowing from overseas has increased by approximately
£24.5bn. It is this increased borrowing from the RoW which has allowed the
government deficit to fall while there has also been a simultaneous modest
upturn in investment and consumption.

This is unsustainable. At a certain point the demand for overseas savings
exceeds the willingness of overseas investors to lend. The British economy is
increasingly dependent on borrowing from overseas and when there is a sudden
withdrawal of funds living standards in Britain will fall dramatically once
more. Traditionally in Britain this has been accomplished by a ‘balance of
payments crisis’ and now more usually relies on a fall in the pound.

It is therefore completely ridiculous for Tory supporters, or the
head of the IMF, to claim that Britain’s recovery offers a model. The world
cannot increase its borrowing to finance consumption from another planet. It is
not even sustainable in Britain.

The requirement to increase private companies’ profitability is the
fundamental driving force behind the proposed resumption of austerity after the
general election. It is quite possible too that there will be a renewed crisis
to accompany it at a certain point, with overseas investors unwilling to
continue financing an increase in British consumption, unsupported by an
increase in production or investment.